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Despite rising global profitability, there has been a “dramatic” fall in UK corporation tax paid by British banks, says Cambridge Judge Business School study.

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There has been a “dramatic” fall in UK corporation tax paid by major UK banks despite strong growth in those banks’ global corporate taxes, a discrepancy that is difficult to reconcile due to meagre disclosure requirements on big banks, according to a recent study at Cambridge Judge Business School.

The study published in the journal Fiscal Studies looked at the “widening gap” between UK corporation tax (UKCT) and global payable corporation tax by the UK’s largest banks, as reported in their annual reports to shareholders. The study “Why are banks paying so little UK corporation tax?” was conducted by Geoff Meeks, Professor of Financial Accounting at Cambridge Judge, and J. Gay Meeks, a Senior Research Associate at the University of Cambridge.

“While profitability of major UK banks recovered to levels seen before the financial crisis, there has been a sharp fall in banking corporation tax receipts by the UK Treasury,” says Geoff Meeks.

The exact reasons are difficult to pinpoint due to incomplete and patchy disclosure requirements on banks, which we believe obstruct analysis. In particular, there’s a paucity of required disclosure on the distribution of large banks’ profits and tax between national jurisdictions.

In current prices, total UKCT receipts from the banking sector declined from £7.0 billion in 2005-06 to £1.3 billion in 2011-12 and £2.3 billion in 2012-13 – or a fall from about 20 per cent of total UKCT receipts in 2005-06 to just four per cent by 2011-12. Using a sample of the six largest UK-incorporated banks in the unusually concentrated UK banking sector (HSBC, Barclays, Royal Bank of Scotland, Lloyds, Standard Chartered and Nationwide), the study found that operating profit of those banks actually increased slightly between 2005-07 and 2010-12, from £139 billion to £143 billion.

In addition to UKCT, banks in Britain have since 2011-12 been subject to a “bank levy” based not on profits but on the balance sheet of equity and borrowing; so far, this new levy has generated less revenue than forecast and has filled only a modest part of the gap in UKCT receipts.

In the UK budget announced in March 2015, Chancellor George Osborne announced that the levy will rise from 0.156 per cent of banks’ liabilities to 0.21 per cent. The bank levy has been criticised by Britain’s largest bank, HSBC, which said earlier this month it would decide by the end of this year whether to move its headquarters from London to Hong Kong.

So what has caused this disconnect between UKCT generated from British banks and those banks’ global profitability?

The study found that a rise in tax-deductible impairments due largely to bad loans contributed to the fall in UKCT receipts for banks, while a decline in the statutory UK corporate tax rate from 30 per cent in 2005-06 to 26 per cent in 2011-12 caused only a “relatively small” reduction of £0.2 billion in UKCT banking receipts.

The study examines closely the reduction, from 30 per cent to 11 per cent, in the UKCT proportion of global taxation reported in the income statements of four of the big banks (Barclays and RBS are excluded from this sample because they had “in the most recent years, not been clearly disclosing the UK component of their taxation total.”). While global tax for those four banks increased slightly between 2005-07 and 2010-12, from £12.69 billion to £12.85 billion, the amount paid to the UK Exchequer declined from £3.8 billion to £1.4 billion, or from 30 per cent of global tax to just 11 per cent. (A three-year period was chosen to reduce the impact of exceptional items in individual years.)

The study asks whether this sharp decline reflects larger profits originating outside the UK, more generous UK tax exemptions, or a reclassification of some UK-originating profits to other jurisdictions – and concludes that “incomplete disclosures” resulting from current reporting requirements for banks results in “mystery” that severely hampers the forecasting ability of both the UK’s Office of Budget Responsibility and the banks’ shareholders. In particular, there is “often patchy or opaque” disclosure on the allocation of taxation between jurisdictions in banks’ annual reports.

These incomplete disclosures “must constrain the OBR’s ability to forecast the tax revenues which are needed to repay the extraordinary government borrowing used to bail out the banking system,” the study concludes. “Similarly, they must hinder the shareholders of the banks in forming their expectations of future earnings – to the detriment of capital market efficiency.”